Weekly Report (12th March, 2023): Risk tone to remain cautious as SVB saga unfolds

Risk tone to remain cautious as SVB saga unfolds

SVB saga could prompt the Fed to reconsider and revise its approach to tightening from here on 

Until now the entire focus was on US inflation and labor market data to determine how much higher the Fed would raise rates and for how long it would keep the rates elevated. However, the recent Silicon Valley Bank (SVB) episode has brought a whole new dimension into focus, one of systemic stability.

The ability of the financial system to withstand such high rates after a prolonged period of low rates was being questioned by quite a few. However the timeline and magnitude of the shock was uncertain as monetary policy acts with long and variable lags. We had seen a glimpse of what damage high rates could cause when the UK bond market went into a tailspin after the mini budget in Sep'22. That episode had irresponsible fiscal policy to be blamed and the issue settled down as the fiscal response was corrected after a change in government. SVB is however the first clear sign from the US that elevated rates are hurting the financial system. Weak risk management practices tend to get exposed when financial market conditions tighten, liquidity wanes and investors become more discerning. In SVB's case it was concentration of funding (deposits mainly from tech startups) and asset liability mismatch (long term mortgage backed securities bought with short term deposits) which were the major reasons for the downfall. The state regulator has intervened, shut down the bank and has roped in the FDIC (Federal Deposit Insurance Corporation) to ensure that small savers are unscathed.

What remains to be seen is whether there would be a systemic fallout on account of the  SVB collapse or whether the crisis would remain ring fenced and contained. Some of the questions to which we will have to find answers are: 

1) How it would affect large depositors? Whether they would be able to recover their deposits to the full extent. 

2) SVB was the 15th largest bank in the US and was naturally well integrated with the banking system. How would it honour the outstanding derivative contracts it would be having with other banks remains to be seen. Whether it defaulting can  result in a domino effect. 

3) How is the health of other smaller banks. Whether they are experiencing similar stresses? 

Until we get clarity on above, we could see risk aversion grip the markets.
We have seen US equities sell off. Domestic equities too could remain under pressure. We are at a crucial support on the Nifty at 17300. We could see a deeper correction if this support gives way 

We have seen a flight to safety. US treasuries have rallied by 30-50bps across the curve. The possibility of a 50bps hike in the March policy has gone down from 80% to 35%. The expectation of terminal rate has gone down from 5.70% to 5.28%. We believe US treasuries will continue to see safe haven demand for a few more sessions. How the saga unfolds until FOMC on 22nd March and what the Fed feels about the episode will matter more now than the CPI print on Tuesday. 

Dollar could remain supported against majors and could strengthen against commodity currencies in particular. Asian currencies would remain under pressure but we expect the Rupee to continue to outperform. We see a 81.60-82.40 range for the coming week with a bias towards Rupee weakening.

Brent and Industrial metals could continue to remain under pressure.

Major data and Events to track

Ongoing SVB saga, closed door Federal Reserve Board of Governors' meeting on Monday 

India Feb CPI on Monday

US Feb CPI on Tuesday

US Feb PPI and Retail sales data on Wednesday

US Feb Housing Starts and Building Permits on Thursday 

US March Michigan sentiment and inflation expectations on Friday

Expected Ranges and Bias

EUR/USD 1.0530-1.0700 with down side bias

GBP/USD 1.1810-1.2020 with down side bias

USD/JPY 133.50-135.50 with downside bias 

USD/INR 81.60-82.40 with slight up side bias.